HyperFINANCE℠ will be Tellusant’s finance module, to roll out in 2 years. But we already use it for other purposes. “Hyper” signifies that our approach to finance builds on hyper-modern methods and that it is agile.
I first used some of these methods when establishing true, not traditional accounting, profitability for airline routes and stations. A few years ago I applied similar methods for a global alcoholic beverages company to see true rather than keyed out profitability.
Below I illustrate the concept at a level that is easy to follow.
Many companies struggle with the split between variable and fixed cost. They use judgement-based keys for allocation. And then operating managers say “the finance people key out costs as variable or fixed, but no one believes the results.” Why not use fact-based methods instead, leveraging machine learning?
The graph below shows variable cost’s share of total cost for 6 companies using the hyperFINANCE method. Results differ materially from the traditional method.
The hyperFINANCE method looks at the underlying variability of costs relative revenue and establishes statistically what the variable cost percentage is (and the fixed cost percentage). With the traditional accounting approach, the variable cost percentage is based on assumptions, sometimes good, other times incorrect.
Notice P&G with 100% variable cost. Can this be true? It can 1) be a fluke; or 2) P&G manages its cost to track revenue (presumably by moving cost between periods). It is impessible to say which. But P&G has the lowest profit variability in the sample-which investors like-which may suggest it is a managed metric.
The graph below explains how. If variable cost is high, then total cost tracks revenue movements well. With profits = revenue − cost, then profits have low variability. Conversely, if variable cost is low (and fixed cost is high), profits have high variability.
Financial beta is a measure of a company’s stock volatility relative to the market as a whole. It is influenced by many factors, profit variability being one. If variable-cost share is high, and thus profit variability is low, beta should be low (approximately).
The graph below shows this. In the left chart the hyperFINANCE approach has the expected relationship: a negative correlation. The traditional approach is nonsensical for the companies. P&G has the lowest beta in the sample and a high variable-cost share.
This relationship is by no means perfect. Alphabet, e.g., does not conform to the theory. But with a large sample it holds fairly well.